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HMRC v Pendragon plc, [2015] UKSC 37

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scheme, exploiting a rule intended to avoid double-taxation so as to avoid tax, was abusive

The Pendragon Group, the largest car sales group in Europe, used a scheme (devised and marketed to it by KPMG) to reduce its VAT liability. Under the scheme:

Step 1: Pendragon bought cars (destined for use as demonstrators in Steps 3 and 4) from a wholesaler, then sold them to four captive leasing companies ("CLCs"). Pendragon paid input tax on the wholesale purchase price but recovered it by accounting for output tax received when the cars were sold to the CLCs.

Step 2: The CLCs immediately leased the cars to Pendragon dealerships. The CLCs paid input tax on the purchase of the cars from Pendragon but recovered it by accounting for output tax paid by the Pendragon dealerships on their rental payments under the leases.

Step 3: The CLCs then assigned the leases and their title in the cars to an offshore bank Soc Gen Jersey ("SGJ"), in consideration for £20m (financed by SG London, which received a further assignment of the assets as security). This assignment, which qualified as an assignment of leased goods to a financial institution, was therefore "de-supplied" (deemed not to be a supply) so that no VAT was payable.

Step 4: Some 30 to 45 days later, SGJ transferred its leasing business including the lease agreements and cars to Captive Co 5 for over £18M. This sale of the business as a going concern was de-supplied.

Step 5: The demonstrator cars were sold to customers by the dealerships, acting as agents for Captive Co 5. Customers paid VAT only on Captive Co 5's profit on the sales, rather than on the total sale price, under the "margin scheme" applicable to second-hand goods, which was available here because the goods had been acquired as part of a business transferred as a going concern.

The scheme was abusive, so that the Commissioners' appeal was allowed.

[I]n the sphere of VAT, an abusive practice can be found to exist only if, first, the transactions concerned, notwithstanding formal application of the conditions laid down by the relevant provisions of the Sixth Directive and the national legislation transposing it, result in the accrual of a tax advantage the grant of which would be contrary to the purpose of those provisions.

…Second, it must also be apparent from a number of objective factors that the essential aim of the transactions concerned is to obtain a tax advantage. ….[T]he prohibition of abuse is not relevant where the economic activity carried out may have some explanation other than the mere attainment of tax advantages.

Respecting the first condition, Lord Sumption noted (at para. 14) that the VAT "broad principle is that tax on the ultimate value of the product is levied only once, albeit that it may be collected at different stages of the process of manufacture and distribution," and (at para. 20) that normally "the reseller seeking to avail himself of the margin scheme will have acquired the goods from someone with no right to recover input tax in respect of their own acquisition of them" so that "the object and effect is to avoid double taxation," whereas "the effect of the KPMG scheme was to enable the Pendragon Group to sell demonstrator cars second-hand under the margin scheme in circumstances where VAT had not only been previously charged but fully recovered…[so that a] system designed to prevent double taxation on the consideration for goods has been exploited so as to prevent any taxation on the consideration at all" (para. 30).

Respecting the second condition, although the involvement of an offshore bank as "it is no part of the policy of the legislation that a party should be restricted in its freedom to select as its commercial partners firms whose place of residence gives dealings with them a tax advantage, even if that is the only reason for their selection" (para. 33) it was essential to the scheme that Captive Co 5 acquire the cars as part of a business as a going concern, and for that to be possible, it was essential that the transferor of the business have acquired the cars by assignment. "[N]either of these two special features of the scheme had any commercial rationale other than the achievement of a tax advantage" (para. 33).

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